INFLATION, LIQUIDITY, AND LONG-RUN GROWTH

Ge Zhou

Macroeconomic Dynamics, 2019, vol. 23, issue 2, 888-906

Abstract: This paper revisits the long-run relationship between inflation and economic growth by exploring the impact of inflation on investment. I illustrate that inflation may have a positive effect on growth by mitigating the liquidity risks of investment projects. Together with the traditional effect of the “inflation tax” on investment, a hump-shaped relationship between inflation and economic growth can be obtained in a calibrated model, which is consistent with the US postwar data. Sensitivity analysis suggests that the degree of financial development and the magnitude of the aggregate liquidity demand help explain the mixed empirical findings.

Date: 2019
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